Kohl’s Profitability Nosedives; New Leadership Provides Some Hope

Indicative of the challenges facing new CEO Tom Kingsbury (see our Feb. 2 note), Kohl’s KSS reported an unexpected loss in 2022′s fourth quarter and offered weak guidance for 2023. Like many peers, it had to resort to high discounting to move inventory in an apparel retail market characterized by excessive amounts of product amid slowing consumer demand. Additionally, Kohl’s continues to struggle to find the optimal merchandising and pricing strategies to hold or gain share. While we think Kingsbury has reasonable plans to fix these and other problems, they will take time to implement.

While poor on an absolute basis, Kohl’s fourth-quarter same-store sales decline of 6.6% was slightly better than our forecast of a 7.5% drop. However, it drove sales through markdowns (especially after Christmas), leading to a woeful 23% gross margin on net sales, 9 percentage points below our already modest estimate. Kohl’s also struggled with cost control, as selling, general, and administrative expenses as a percentage of revenue were 140 basis points above our forecast due to higher wages. Consequently, its operating margin was negative 5% and it reported an EPS loss of $2.49. For 2023, Kohl’s guided to a sales decline of 2%-4%, an operating margin of 4.0%, and EPS of $2.10-$2.70, short of our estimates of 1.5% growth, 4.7%, and $3.06, respectively.

We expect to cut our $54 fair value estimate on Kohl’s by a high-single-digit percentage given the results and sour outlook. Even so, we see value in its shares. On the call, Kingsbury highlighted strategic initiatives, including merchandising and pricing changes, enhancements to loyalty and credit card programs, debt reduction, and better inventory and cost control. While we rate Kohl’s as a no-moat firm and expect some of these plans to fall flat (as in the past), we are encouraged by Kingsbury’s success as CEO of narrow-moat Burlington. Meanwhile, Kohl’s offers an attractive dividend (7% yield), which we believe is safe.